Hedge fund risks

The collapse of Amaranth earlier this year, with a loss of about
USD6 billion, was easily absorbed by the financial markets, a far better
reaction than the collapse of LTCM in 1998, with a smaller loss (USD
4.5b).

An interesting speech
by Lars Nyberg, deputy governor of the Swedish central bank, entitled
“Are hedge funds dangerous?” goes through many of the issues that arise
from hedge fund market operations very well and covers the three
differing types of hedge funds quickly, but understandably.

Importantly, he also offers some conclusions on whether the funds
need to be regulated in a more heavy-handed manner. His conclusion:

From a stability point of view, the central issue is that
the systemically-important banks should manage their counterparty
exposures correctly – take sufficient collateral, have appropriate
limits and be capable of managing potential liquidity problems. The
arguments for further regulation of hedge funds are in this context
weak.

While the metrics are, for obvious reasons, relevant only to the
Swedish market, the conclusion is, I believe, a robust one in most
contexts. If the banks that the majority of people are using are doing
their job correctly they form the “buffer” between the more adventurous
in the markets, who provide much of the liquidity these days, and the
relatively stable day to day environment most of us live in.

In short, we all benefit from their operation by the additional
liquidity they bring, and from the consequent improvement in the
price discovery mechanism. An attempt to regulate them further would
only reduce the benefits they bring without serving any useful purpose
in mitigating